What is a Capital Loss and How Does it Work?

Posted Feb 4, 2023

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We frequently talk about capital gains, including the definition of short- and long-term gains, tax implications, and management strategies. We don’t discuss capital losses as often because no one wants to talk about losing money or value, right? Still, capital losses are part of reality when you invest, and understanding how they work can be helpful in seeking to manage your overall portfolio.

When do I experience a capital loss?

As with gains, losses result from a change in the asset’s value. Also, like capital gains, losses may be either short or long-term. For example, suppose you purchase 100 shares of stock at a share price of $10. If the price increases to $15, you have a capital gain. However, you have a capital loss if the price declines to $5 per share. Whether the gain or loss is considered short- or long-term depends on how long you have owned it. If the holding period is less than a year, that is short-term, while any period greater than a year is long-term.  

Remember, you only experience the loss (or gain) if you dispose of the asset. Your stock may drop precipitously, causing you distress, but you haven't incurred a loss if you don't sell it. The same is true for stocks that increase in value. That $10 stock could reach $100, and you won’t owe capital gains taxes unless you sell.

What about real estate losses?

The type of asset isn’t material. If you own investment property that appreciates, that is a capital gain when you sell or dispose of the property. If you sell a property for less than your basis (what you paid for it plus other associated costs), that constitutes a loss. The same holding period determinants apply to whether the change is short or long-term.

What are the tax implications of a capital loss?

The IRS does not levy taxes on losses, but that doesn’t mean they aren’t important to consider for tax management. Capital losses can decrease your income, which can help lower your tax obligations. There are several means to use capital losses to offset capital gains and even ordinary income. Here is how it works:

  1. Capital losses can offset capital gains. First, the loss offsets gains of the same type. For example, if you have a long-term loss, you can use it to offset a long-term increase. If you have unused long-term losses, you can offset short-term gains. The converse is also true (offsetting long-term gains with unused short-term losses if you have insufficient short-term gains to absorb the available loss fully).
  2. If you have more losses than gains in total, you can use the remaining losses to offset ordinary income. The annual limit is $3,000 for a married couple or $1,500 for a single filer. If you have remaining losses (after offsetting other capital gains in both short-and long-term categories), you can roll over the additional losses for use in the next year.

What does tax loss harvesting mean?

Tax loss harvesting is a strategy to pursue overall tax reduction by selling some assets that have lost value. For example, if you own 100 shares of a stock that has dropped from $150 per share to $100 that is a capital loss of $5,000. You can hold onto the stock and hope that the price recovers. Or you can sell it and use the loss to offset gains you enjoyed with other assets. Remember, the loss is first applied to profits with the same holding period classification, then to other capital gains, and finally to ordinary income. Keep in mind that you can't repurchase the same stock within 30 days, or it is considered a wash sale, and you will lose the advantage of the offset.

This material is for general information and educational purposes only. Information is based on data gathered from what we believe are reliable sources. It is not guaranteed as to accuracy, does not purport to be complete and is not intended to be used as a primary basis for investment decisions. It should also not be construed as advice meeting the particular investment needs of any investor.

Realized does not provide tax or legal advice. This material is not a substitute for seeking the advice of a qualified professional for your individual situation.

All real estate investments have the potential to lose value during the life of the investment. All financed real estate investments have the potential for foreclosure.

Hypothetical examples shown are for illustrative purposes only.

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